Sunday, 15 March 2009

The recent financial crisis which originated from the 2007 US sub-prime crisis has been labelled as the worst financial crisis since the Great Depression by George Soros, Joseph Stiglitz, and the International Monetary Fund (IMF) (Jaffee, 2008; Tong and Wei, 2008). It has now become a full-blown global economic crisis. Due to the borderless nature of the global economy, the economic downturn in the United States has created a systemic shock that has been transmitted to the economies around the world. So, the crisis has inflicted heavy damage on markets and institutions at the core of the global financial system (IMF, 2008). While many believe that the "worst is not over", continuous deliberations are ongoing to diagnose the root of the crisis and find solutions to the current problems that the global economy is facing. Just like the cases of previous crises, once the crisis sets in, continuous efforts are undertaken to improve and strengthen the current financial infrastructure so as to avoid such crisis from happening again in the future. This crisis of 2008 is unprecedented in its nature. Even the well-established and what is considered "too big to fail" financial institutions are being badly affected by the crisis (Citibank, Lehman Brothers and AIG, just to name a few).Successful PrinciplesOn the contrary, the Islamic banking and financial institutions throughout the world are somewhat "sheltered" from the global financial shocks. Despite slowing down, the top ten Islamic banks continued to show encouraging performance by recording an average annual growth of around 30 percent for 2008. While conventional banks consolidate and retrench workers, Islamic banks particularly in the Gulf Coopeartion Council countries continue to expand and recruit new workers. The resilience of the Islamic financial institutions to the current financial shocks, as well as their robust growth have led many quarters to conclude that Islamic banking could provide a solution to the current financial ills and be a viable alternative to the current financial system. The current crisis seems to highlight the weaknesses of the conventional banking and finance philosophy on which the global financial system is built upon. The conventional system allows multiple debt creation on a particular asset without a real underlying transaction made possible by credit default swap. Quite the contrary, Islamic finance requires that financial dealings must be backed by real assets and be in line with the Islamic law, Shariah. Generally, the principles upon which Islamic banking system is built on ensure the element of certainty and stability in financial dealings. In particular, the requirements that the financial dealings must be free from Riba (interest), gharar (uncertainty), and maysir (gambling) ensure that the elements of exploitation and excessive speculation are avoided. To ensure fairness and justice, financial dealings in the Islamic context must observe the concept of iwad (equal counter-value, which comprises of work effort, risk assumption, and product liability). There are various supervisory authorities that are committed to oversee the overall compliancy of the financial instruments offered by the Islamic financial institutions, such as the Shariah supervisory board, as well as national regulatory authorities. More importantly, financial dealings in Islamic banking and finance are guided by the ultimate objective of achieving the ideals of equitable justice where priority is given to equity-based financing rather than debt-based financing. The conventional financial system which focuses largely on debt-based financing has resulted in concentration of wealth circulated largely among the deemed credit-worthy corporations and individuals. In the Islamic economy, priority should be given to transactions that can benefit the society at large, rather than just the already wealthy corporations, so that wealth can be more widely circulated. As such, the concept of equity-based financing along with its profit-sharing element is again another built-in stability aspect of the Islamic financial system. The joint-venture nature in most equity based financing such as musharakah ( equal sharing) requires active participation from both the financier and the borrower to achieve the best outcome of a business venture. Equity-based financing distributes risk and liability to both the lenders and borrowers so as to justify the return to both sides of the transacting parties. In the end, this would influence the allocation of wealth and resources in the economy. While conventional banks worldwide are nursing losses of more than $400 billion from the credit crisis, Islamic banks are virtually unscathed.Demand for Interest-free FinanceSurprisngly, Islamic banks, such as Al-Rajhi Bank of Saudi Arabia, Kuwait Finance House, Dubai Islamic Bank and Maybank Islamic, grow steadily during the crisis. Because of Islamic banking's merits and virtues, the demand for its products expanded not only in the Islamic countries, but also in the western countries, such as the United States and the United Kingdom. In the light of the current crisis, it is expected that there will be a large scale re-evaluation of the guiding principles of financial transactions globally. The Islamic economics model in general, and Islamic banking and finance in particular, are viable options as the search for more stable and safer global financial infrastructure continues. The global credit crisis presents the $1 trillion Islamic finance industry with an opportunity to expand its appeal beyond Muslim investors, as a haven from speculative excess. Already, Islamic financial institutions have made in-roads in many western countries such as the United States and the United Kingdom. In fact, in these countries, the attention towards interest-free financial products, particularly for long-term financing such as home financing, has been there since the mid-1980s. The demand for interest-free home financing product has led to the establishment of several Islamic financial institutions in the United States such as the MSI Financial Services Corporation which was established in 1985 in Texas, the American Finance House-LaRiba (1986) in California, and University Islamic Financal Corporation (2005) in Ann Arbor, Michigan.

Remarkable Growth

In addition, there are many Islamic banks outside the United States, like al-Ansar Co-operative Housing Corporation Ltd (1981) in Toronto, Canada, Islamic Bank of Britain (2004) and European Islamic Investment Bank (2005) in the United Kingdom, Faisal Private Bank (2006) in Switzerland, and many more throughout the world.

In the aftermath of the sub-prime crisis, it is most likely that the demand for Islamic banking products and services to increase.

Moreover, the number of the Islamic financial institutions offering more innovative products and services is most likely to increase.

The Asian Development Bank estimates that Islamic assets globally have a combined value of about $1 trillion, with annual growth of 10 percent to 15 percent a year by 2010.

Despite this, it is important to highlight that even though the ideals of Islamic banking and finance lead to countless merits and virtues, the actual implementation and practices by the financial institutions is a whole different issue.

Thus, it would be beneficial that the Islamic financial institutions could learn from the current crisis that the expansion driven by stiff competition without being guided by the ideals proposed by Shariah and the true objectives of the Islamic economy could be devastating.